Turkey’s new tax reform package is a step backwards
Turkey’s ruling Justice and Development Party (AKP) has introduced a tax reform package that fails to address the most important problems of revenue collection and could be called an anti-reform as it could make things worse.
The package includes new taxes in three main areas - digital services, high-value real estate, and housing services - and makes changes in income tax rates.
The package does not aim to redesign or rationalise the tax system, but focuses instead on increasing revenue in order to cope with the financial burden of three years of election-oriented populist policies.
Any real tax reform needs to simplify the tax system and normalise tax rates. But most importantly it means increasing the percentage of people who actually pay tax. That means increasing the number of people who are obliged to provide annual tax returns.
That would not mean everyone would pay tax, but it would establish a relation between individuals and the public finance system, increasing the awareness of people as taxpayers, which is necessary for an efficient economic system, but more importantly is the basis of the rule of law and a strong democracy.
Turkey should also introduce negative income tax; that is, subsidising people whose net income falls below a certain threshold.
Policymakers designed the tax system so that taxes were deducted at source in the belief that most employees lacked the educational skills to file more complex annual returns. But this is no longer the case.
Turkey’s top business group Turkish Industry and Business Association (TÜSİAD) last week called for a rethink of the proposed tax reforms, saying they would increase the tax burden on businesses.
“Tax regulations are one of the basic issues of our economy and public life,” TÜSİAD said. “What our country needs is a tax reform that will decrease the size of the informal economy, broaden the tax base and make our tax laws simpler, fairer and more understandable.”
The informal economy is one of the country’s most important problems and the main reason for the failure to establish a strong revenue collection system. Treasury and Finance Minister Berat Albayrak said in a presentation on Sept. 30 that the size of the informal economy had increased to 36 percent of the gross domestic product. Only a more reasonable, more rational tax system can shrink the shadow economy, but the proposed measures will encourage it.
Reducing the number of tax brackets and reducing the highest tax rate would encourage people not to hide additional income sources. But the government’s tax reforms envisage increasing the number of tax brackets and increasing the highest income tax rate from 35 percent to 45 percent.
The proposed tax reform will further irrationalise Turkey’s public finance system, rather than rationalising it. It might seem like a reasonable choice for a government only focusing on increasing tax revenues in the short term, but even those short-term expectations may not be fulfilled and tax revenues are likely to decrease in the medium and long terms.
There is also another issue. It is impossible to introduce an efficient tax system in a country where people have suspicions about the legitimacy of public expenditure and are wary of corruption. In such circumstances people tend to evade paying taxes.
Reforming the tax system is something Turkey really needs, but it means creating consent and trust through political legitimacy, which in turn is only possible by respecting the rule of law.